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Brexit: Sterling's slide remains the continuing feature - BBH

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Feb 24, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    Research Team at BBH, suggests that Sterling's slide remains the continuing feature in the foreign exchange market as Brexit fears dominate.

    Key Quotes

    “It has convincingly broken the $1.40 level and is trading near $1.3915. It has lost about 3.4% this week already. In terms of economic impact, sterling's trade-weighted performance is key. The Bank of England’s effective exchange rate measure has fallen 8.7%, of which 5.4% has been recorded this month alone.

    UK officials are likely more concerned about the pace of the move than the direction. The pass-through to inflation may take several months provided it is sustained. To the extent that there is a trade advantage, it likely takes even longer to be seen.

    Not only is sterling being sold in the spot and forward market, but some investors seek protection in options market. Implied volatility is rising, which suggest puts being bought rather the calls being sold. Three-month implied volatility is near 11.5% today, up from 8.7% at the end of last year and 8.9% at the end of January. Last April, three-month implied volatility spiked to 12.5%.

    In the options market, puts and calls equidistant from the forward strike should be similarly valued. To the extent they are not reflects a market bias. Three-month sterling calls are selling at a 1.5% discount to puts (risk-reversal). This is the biggest discount since last May. Last April the discount was near 3%.

    The takeaway from the options market is that the pace of sterling's decline and the market's anticipation of further declines (as reflected in the risk-reversal) do not show sterling at some kind of extreme, even though the market is stretched. In the spot market, sterling is trading well through its lower Bollinger Band (~$1.4025), which is set two standard deviations below its 20-day moving average. Three standard deviations from the 20-day moving average comes in near $1.3850.

    What Churchill said about the Americans (that they can be counted on to do the right thing after exhausting the alternatives) might apply to the UK now. The event markets and many polls still point to the UK staying in the EU. However, because of the significant potential impact of Brexit, sterling exposure is being pared and hedged, and based on discussions with numerous market participants, we suspect that it is too early to try to pick a bottom in sterling (against the dollar and crosses).”
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